For each of the following events, use the aggregate supply and demand model to determine the short-run change in the economy’s price level and real output.
a. A stock market crash reduces households’ wealth.
b. OPEC succeeds in raising the price of crude oil, an important resource.
c. A decrease in interest rates leads to an increase in the level of investment spending.
Question 2
Suppose the government decides to reduce its spending on goods and services.
a. What would be the short-run consequences of this decision on the equilibrium price level and real output? Use the AS-AD model to illustrate.
b. What would be the long-run consequences of this decision on the equilibrium price level and real output? Use the AS-AD model to illustrate.
Question 3
Use the table below, which shows consumption and investment spending as functions of disposable income for Nelsburgiaville, to answer the following questions. There is no government spending in the country, which also does not trade with the rest of the world. All figures are in millions of Nelsburgiavillian dollars (N$).
planned
DI C I
2000 2300 500
3000 3100 500
4000 3900 500
5000 4700 500
6000 5500 500
7000 6300 500
8000 7100 500
a. What is the marginal propensity to consume in Nelsburgiaville?
b. What is the marginal propensity to save in Nelsburgiaville?
c. What is the equilibrium level of disposable income in the country?
d. If income was $7000 million, explain the process by which the income of the country would change to the equilibrium level.
e. If income is $7000 million, how much money are households saving?
f. If income is $7000 million, how much money are firms spending on investment?
Question 4
Economists observed the only five residents of a very small economy and estimated each one’s consumer spending at various levels of current disposable income. The accompanying table shows each resident’s consumer spending at three income levels.

a) What is each resident’s consumption function? What is the marginal propensity to consume for each resident?
b) What is the economy’s aggregate consumption function? What is the marginal propensity to consume for the economy?
Question 5
The graph below shows the consumption function for Nelston, a country with no government and no trade with the rest of the world. All figures are in millions of Nelston dollars (N$). Use the information to calculate the following.

a. What is the marginal propensity to consume in Nelston?
b. What is the marginal propensity to save in Nelston?
c. What is the equilibrium level of income in Nelston?
d. If income is $2600, how much money are households saving?
e. If income is $2600, how much money are firms spending on investment?
f. What is the value of the simple spending multiplier?
Question 6
The marginal propensity to save in Noslenia is 0.125. Use this fact to answer the following questions.
a. What is the value of the marginal propensity to consume in Noslenia?
b. What is the value of the simple spending multiplier in Noslenia?
c. Suppose that firms, because of lower interest rates, decide to increase their investment spending by $700 million. By how much will this increase in investment spending increase equilibrium disposable income?